How do franking credits actually work?

Politicians are going crazy over franking credits, but what does it all mean?

This Google trends chart reveals a massive spike is searches for "franking credits" during the election. Picture: GoogleSource:Supplied

It’s not exactly a sexy topic of conversation — but Aussies suddenly went from being mostly in the dark about franking credits to obsessed with them during the election campaign.

The controversial tax system made national headlines this year after Labor vowed to scrap franking credit refunds if it won government.

The Coalition hit back, promising to keep the rebate and labelling the ALP’s plan a “retiree tax”.

Regardless of which party you sided with, it’s undeniable it became an issue many everyday Australians cared about virtually overnight.

That much is clear from the graph below, which shows Google searches for the term “franking credits” in Australia were flat in January this year — only to spike dramatically in May when it suddenly became a hot topic.

It became such a heated issue investor Geoff Wilson later claimed it had paved the way for a Coalition win, along with the Adani coal mine debate.

The fund manager and his investors had campaigned heavily against Labor’s policy, and at an event in late May, he told supporters those two issues had cost Bill Shorten the government.

“It was franking credits, and in Queensland it was the fact that Bob Brown came up with his caravan, they were the two main factors,” he said, according to the Sydney Morning Herald.

“I think that one thing that Labor underestimated was the intergenerational impact that this change was going to have.”

Many commentators and experts have since taken to Twitter to claim while franking credits may have influenced the 2019 election results, it’s an issue that probably won’t go away any time soon.

The Coalition described Labor’s policy as a “retirement tax” — and went on to win the election. Picture: Darren England/AAP ImageSource:AAP

And with many Australians now more likely to jump on the franking credit refund train now it has been put on the national radar, many believe the policy will only grow increasingly divisive over time.

That’s because franking credit refunds now cost more than $5 billion a year compared with around $500 million when it was first introduced in 2011.

But as more and more of us take advantage of the system — which many believe will happen — that already staggering figure is likely to blow out even further.

FREE MONEY, FREE MONEY !! .... the news is out! Listening in to the cafe chatter in Kew this week, all the oldies are all talking about getting into the franking credits gig. Buying bank shares mostly. No wonder bank shares went up!

According to Sandi Keane, an investigative reporter and editor-in-chief at independent news site Michael West, it could already be happening.

In an article written in the wake of the shock election result, Ms Keane reported “bank shares have shot up since the surprise election result as new investors pile onto the great franking credits bandwagon”.

She also described being inundated by thousands of responses to several tweets she had published regarding franking credit refunds, with one Twitter user claiming their superannuation adviser told him a “can of worms” had been set loose by the debate, and he had been “bombarded” with clients “asking about this gift of free money”.

I met with my #industry#superannuation fund adviser on Thursday. He told me in conversation “..a can of worms has been set loose” as they have been bombarded with clients asking about this ‘gift of free money & and how can they access this?

Richard Denniss, the chief economist and former executive director of influential progressive think tank The Australia Institute, said the very issue that could have helped the Coalition this year may come back to bite it next time around.

“When Peter Costello first introduced this loophole, it was estimated to cost around $500 million a year — now it costs $5000 million, and that was before most people knew it was there,” he told news.com.au.

“The Liberal Party spent the last six months defending the right of people to pay negative tax, so it would hardly be a surprise if a lot more people were now eager to pay negative tax.

“Millions of Australians have now learnt of the existence of paying negative tax, and if they pursue these tax strategies then it will definitely blow a big hole in the Coalition’s surplus.”

Dr Denniss said the Coalition’s “scare campaign” about an “imaginary retirement tax” might have had some impact on the election results.

“Even though only 4 per cent of Australians receive franking credit refunds, the Coalition did a great job of scaring a large number of people, and it may well have done a great job of selling a highly effective tax minimisation strategy,” he said.

“I’m sure there are a lot of people talking to their accountants today about how they can pay negative tax, and that’s going to have a significant impact on the Government’s ability to deliver its forecasted surplus.”

Meanwhile, Dr Andrew Grant, senior lecturer at the University of Sydney Business School, agreed most people had barely heard of franking credits before it was brought up during the election campaign.

He told news.com.au many people had been confused by Labor’s plans to scrap the refund, as it had been incorrectly dubbed a “retiree tax”, but it was “a bit extreme” of critics of the refund to claim most people taking advantage of it were rich with massive share portfolios.

“I teach corporate finance classes and it’s confusing for (my students), so it’s not surprising it’s confusing for other people, particularly how they framed it as a tax on retirees when really it was the removal of a bonus,” he said.

“That’s not the same as a tax, although it can be construed as a tax depending on who you are.

“It does highlight how people can be influenced by what is brought to their attention.”

WHAT ARE FRANKING CREDITS?

If you’re a shareholder, you get paid a dividend when the company makes a profit — and normally you would have to pay tax on that, just like you would with your regular wages.

But in 1987, then-treasurer Paul Keating introduced “dividend imputation credits” — also known as “franking credits” — which were designed to prevent double taxation.

Basically, it recognised the government already taxed companies’ profits, so it wasn’t fair to then tax an individual a second time around.

So shareholders were given a sort of “I owe you” — they were able to deduct the amount the company had already paid in tax off their own taxable income.

But in 2001 under the Howard government, then-treasurer Peter Costello took it one step further and changed the rules to allow that tax deduction to be swapped for a cash refund.

It meant even shareholders who didn’t pay tax — like retirees — could still be given a cash refund from the ATO.